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A comprehensive guide on how to reduce procurement costs, written to provide you with ideas, tips and strategies to help you uncover hidden procurement spend.
If you're looking for ways to reduce your company's procurement costs, you're not alone.
In today's business environment with surging inflation, cost reduction has become a top priority for organizations of all sizes. By minimizing procurement costs, you're able to free up resources that can be used to pursue other areas of growth in your business.
Most organizations don't realize that they have millions of dollars worth of hidden procurement spend just waiting to be uncovered. There are pockets of increasing spend hidden in your spend data, and uncovering them can drive huge efficiency savings.
But how do you do it? How do you find those pockets of hidden procurement spend?
The best way to do this is by implementing a methodology that has instant and lasting effects.
In this guide, we'll explore ways to reduce procurement costs that are proven to work and easy enough for anyone to implement.
What Is Cost Reduction in Procurement
It's no secret that cost reduction is a crucial component of procurement. But what exactly does it mean?
When we talk about cost reduction, we're not just talking about saving money when you buy. Cost reduction is an across-the-board effort that includes getting the best prices on what you buy and making your organization more profitable by cutting out waste.
Cost Savings vs. Cost-Cutting
Cost savings and cost-cutting are two different concepts. While they may be related, cost cutting is a last-ditch attempt to save money. Cost savings, on the other hand, is a voluntary process that can increase productivity and profit.
Cost-cutting is often a desperate measure taken by businesses when they are suffering from financial difficulties. It involves making changes to the company's operations, which may include laying off employees or reducing their pay. The goal of cost-cutting is to reduce expenses as much as possible so that the company can continue to operate without going out of business.
On the other hand, cost savings is different as it's about identifying ways to reduce costs and often involves methods that uplift the company and help it grow.
8 Quick Ways to Generate Procurement Cost Savings
Purchasing is one of the most important functions of any business. It requires a proper plan for procurement savings to decrease costs, improve supplier management, and add up to the bottom line. There's a wide range of procurement saving ideas, some simple to implement, others more complicated or time-consuming. Depending on your business needs and scale, here're 8 procurement cost reduction strategies you can consider for your business.
1. Consolidate and Centralize Data
To make sure you're spending your money wisely, you first need to collect accurate data. Connect all your procurement data to get a complete picture of your critical metrics. Then you can use a centralized database to see which items you should purchase more or less frequently, whether sales and inventory meet up, and whether you should change a supplier.
It provides you with real-time reporting and enables you to find cost reduction techniques in procurement.
2. Improve Payment Terms
Payment terms are one of the most powerful levers to improve working capital. To influence payment terms, compare supplier payment terms across regions or within a category to understand the differences.
Once you have identified suppliers with sup-optimal terms, request longer payment terms by demonstrating how their terms are worse than other suppliers in, for example, that category. By prolonging payment terms, you can improve your working capital.
3. Bundling Spend With the Most Competitive Suppliers
The savings aren’t just limited to price. By bundling the spend with fewer and most competitive suppliers, you also reduce complexity and time spent on procurement. You can also use this opportunity to negotiate better terms, such as payment terms and delivery schedules.
Let's say you have 13 suppliers all providing a similar product for a yearly spend of 1.9M USD. By bundling the spend with, e.g., 2-3 suppliers, you can often negotiate a substantial price reduction.
4. Negotiate Better Terms
Are there any terms that can be improved? Suppose you want to reduce your total cost of ownership (TCO). In that case, your suppliers must work together to reduce costs without affecting service levels or the quality of products/services delivered. You could ask them to reduce their prices if they can deliver on agreed service levels or vice versa.
Also, consider negotiating for better payment terms if you want to identify which suppliers have increased their prices unreasonably, price variation across BUs from one supplier, or you want to address price differences across suppliers.
For example, if a supplier offers free shipping when buying more than 100 units, ask for free shipping for buying only 50 units. In some cases, it may not be possible to get better terms, but it’s worth asking as often they will accommodate this request if it helps them sell more products/services.
5. Reduce Maverick Spend by Increasing Contract Coverage
Maverick spend is a serious issue for companies, as it can cost them millions of dollars per year. One type of Maverick spend is purchases outside a contract – which can be proxied by connecting contracts to spend. You can leverage this connection to identify purchases (suppliers or products/services) without a contract.
By addressing these "rogue" purchases, you can negotiate standardized terms in a contract or shift spend to alternative suppliers with a contract. Typically addressing maverick spend can reduce costs by 5% on average – in a 54M USD category that translates to savings of ~200K USD / year.
6. Regularly Evaluate Your Suppliers
As a procurement professional, you know that one of the best ways to ensure your success is to find great suppliers who can deliver what you need when you need it. Keep tabs on your vendors: If you evaluate your suppliers regularly, you'll be able to assess whether you're getting the best deal for your business. Not just that, it also helps you understand performance and improve it going forward. For example, more timely deliveries, higher quality services or items, etc., which over time will lead to lower costs.
Over time, you’ll have a list of vendors that fit your needs and optimize spending.
7. Reduce Transaction Costs
Suppliers often have to send you a separate invoice for each purchase. Companies, on average, receive multiple invoices per day per supplier. Adobe estimates that the cost of processing an invoice could range from 15-40$. That's a lot of paperwork, which means a lot of costs.
Adobe estimates that the cost of processing an invoice could range from 15-40$.
Suppose your company receives 5000 invoices per month, and you can group purchases into fewer invoices to reduce the number of invoices by 5-10% (250-500 invoices). This translates to an efficiency gain of 6K-15K USD / month or ~70-180K USD / year.
8. Reduce Supply Risk
Risk management helps you reduce or avoid risks to your business, so it's an essential skill to develop. Having a complete plan in place will better prepare you to handle unexpected events and avoid unplanned costs.
One of the most common risks facing organizations is supplier dependence—that's where there are no alternatives if something goes wrong with the supplier. Reduce risks to your business by procuring goods and services from a diversity of suppliers. If one supplier cannot supply the goods or services you need, you have other options. Furthermore, make sure that you have clear contracts with your suppliers, so there are no unexpected logistical problems.
Why Is Cost Reduction Necessary in Procurement
Cost reduction is the most sought-after advantage because of the direct impact it has on profit margins. When a company performs cost reduction to increase profits, they have more money to invest in other areas. This can be used to protect their profit margins and make sure that they're able to consistently offer goods and services to customers at favorable costs - ultimately increasing and safeguarding profit margins.
The current business environment is particularly a challenging one. Many businesses are facing inflation in many of their categories, with some even needing to keep their business alive. Hence, cost reduction is more important than ever before to make sure that companies can stay competitive in this environment.
Cost reduction helps improve the procurement processes' standards by directly affecting the nature of the current procurement methods, which makes it easier for companies to purchase goods, services, or assets at reasonable prices without compromising on quality.
How Strategic and Data-Driven Procurement Reduce Costs
Do you know what the average business spends on procurement? It's 65%-75% of their outflows! That's a lot of money, and it's crucial to your company's success.
The key to success for any business is cost reduction. Whether you're a small company or a large corporation, it can be the difference between failing and thriving. And when it comes to reducing costs, there are many different methods available to you. One of the most important ways to reduce costs is using data to guide procurement decision-making and following an effective, strategic approach.
Effective procurement begins with understanding what your company spends and how that spending can be optimized. The first step is collecting your spend data in one location, across internal systems, connecting it with external data and analyzing it. This step is crucial to understand where you're spending money and where you have opportunities—e.g., in terms of transaction costs, bundling, negotiation, payment terms, etc.
Once you have collected and analyzed your data, it's time to prioritize what areas to address first. This is where our prioritization matrix comes in handy. It evaluates the ease of implementation and impact so you can make decisions based on the most important factors for your organization. You can download your free copy of the Prioritization Matrix here: Prioritization Matrix Template.
Once you have a list of what areas to address first, the next step is to execute accordingly. For this, you can use our renegotiation meeting template to conduct structured and fact-based renegotiation meetings with your suppliers. A Renegotiation Meeting template and script helps you prepare for and execute your priorities. Start by setting up your goals for the meeting and making sure that you have all of the information necessary for this meeting. Then, use our template to help guide you through every step of the way. You can also download a copy here: Renegotiation Meeting Template.
Last but not least, it's not just about getting a quote and having the work done. The last step is to track and follow up spend with addressed suppliers. This includes making sure that you and they stay loyal to agreed contracts.
How Do You Calculate Cost Savings in Procurement
Calculating cost savings in procurement isn’t a simple task. In fact, it's not even possible to measure cost savings without considering other factors at play. Because of this, you'll need to consider your options carefully when measuring savings.
For example, you could use a new negotiated price as a baseline for calculating cost savings—but this will only be accurate if you have access to previous costs for comparison purposes. If you don't have those numbers available, another option is to use market benchmarks as a starting point for your calculations.
To calculate cost savings in procurement, experts usually subtract the average price of all quotes received from the negotiated contract price. The actual number of items bought during the period of calculation is then multiplied by this value.
Bridging the Gap Between Procurement and Finance
Procurement and finance both have a lot to contribute to the success of a company. However, these two departments can have different goals and priorities.
Procurement is often interested in reducing costs and increasing savings, while finance is more focused on increasing revenue and profits. However, these two departments need to work together if they want their efforts to be successful.
For example, procurement may come up with an idea for saving money by using a new supplier that charges less than the current supplier. Finance might not be convinced that this will translate into increased profits.
So how do you get these departments on the same page?
First, they should agree on a common definition of savings so that they know what they're talking about when they talk about savings. They should also come up with a baseline for spending so they can measure how much each department is spending or saving compared with this baseline.
The best way to do so is to use technology—like Ignite Procurement—to establish a good data foundation and track your company's spending over time so that everyone involved can see what kinds of changes are happening within each department and area over time.
How You Can Reduce Procurement Costs With Ignite
When it comes to your company's bottom line, every dollar counts.
And with Ignite, you can take control of your spend and make sure that every penny you pay for goods and services is well-spent.
Ignite can help you increase payment terms, improve cash flow, reduce your supplier base and eliminate maverick spend. We've seen it happen time and time again—and we can show you how to do it too.
With our specialized dashboards that show spend across various levels and let you see which products and suppliers have increased prices the most and where to focus your efforts, you'll be able to drill down further to find out how you're spending your money and where the opportunities are. Proactive alerts will detect anomalies that open up new ways to lower your total cost of procurement.
With a consolidated view of your spend across suppliers, you can bundle spend with fewer suppliers and negotiate a better price for those contracts. Ignite also connects contracts to spend to identify and address 'rouge' purchasing, negotiate standardized terms in contracts or shift spend to suppliers with a contract. Not just that, with Ignite, you can also reduce the number of invoices and save thousands of dollars by cutting the cost of processing invoices.
So what are you waiting for? Get started today with Ignite!